Posted
by
Soulskill
on Tuesday April 21, 2015 @06:25PM
from the moving-at-the-speed-of-government dept.

New submitter dfsmith writes: Apparently the "Flash Crash" of the stock market in May 2010 was perpetrated by a futures trader in the UK. The US Justice Department alleges that he used a "dynamic layering scheme" of large-volume sell orders to confuse other buyers, hence winning big in his futures trades. "By allegedly placing multiple, simultaneous, large-volume sell orders at different price points—a technique known as 'layering'—Sarao created the appearance of substantial supply in the market. As part of the scheme, Sarao allegedly modified these orders frequently so that they remained close to the market price, and typically canceled the orders without executing them. When prices fell as a result of this activity, Sarao allegedly sold futures contracts only to buy them back at a lower price. Conversely, when the market moved back upward as the market activity ceased, Sarao allegedly bought contracts only to sell them at a higher price."

the real problem isn't his tactic.. it's the way the markets allow for robo traders in the first place.

Yeah. It's the robo algos that sent the market into the flash crash as a result of this guy's trading. If he had taken his trading plan and implemented it as an algorithm to do the same thing, he probably could have just called it "arbitrage" and been scott-free.

it even describes layering as something that "was" sort of an industry standard practice.

How does having a name make it an industry standard practice? "Ponzi scheme" has a name too and it is illegal. I don't see and reference to "layering" being standard practice.

is it strange to ask for a facility into hft that would cancel unprofitable trades?

He cancelled trades that would have been profitable but that he had no intention of fulfilling. He created a large volume of sell offers just above the market price knowing that no one would buy them but that it would make it appear that there was a lot of supply. That drove down the price. He then lowered his offers to keep just above

This is just smart trading. I know 100 guys that COULD do this, assuming they had the requisite margin. As long as you place trades on the book that you're willing to fill based on the rules of that market there's no reason why you should be called a 'crook' for that.

It wouldn't be, if spoofing weren't a crime. The US could have simply not made it a crime in this case and then it wouldn't be "blatantly illegal" for small traders to do.

And notice how the problem is due to poor market design. Instead of fixing markets so that it isn't possible to "cancel before execution", they implement ridiculous rules and laws instead.

Consider this analogy. How many people here think it's a good idea to modify US law just to protect the *IAA business models? So why is it acceptable to modify US law just to protect stock market business models?

So lets say I have a standing order to buy FooBar stock at $50 a share. Its current price is $55. So basically I'm looking to buy on dips.

Tonight it comes out that the CEO has been falsifying all financial reports, and instead of making money for the last 3 years they've lost millions. You don't think I should be able to cancel that buy order due to the new information?

I don't think anyone's suggesting that your orders should sit there forever.

What would seem reasonable is that there should be a minimum delay between submitting an order and cancelling it (or even submitting it and having it appear on the market), and that delay is of the order of 10ths of seconds rather than nanoseconds as is currently the practice of HFTs.

A very easy way to achieve that is to put a great big loop of wire (i.e. several km minimum) between every brokers' order entry systems and the exchang

Do fluctuations at those levels REALLY reflect changes in the actual value of a company? At 4:01.000000001 PM is GM really worth 14.01, but at 4:01.0000000012 something changed and it is now worth 14.02? And what is the cost of having this "extra resolution?"

Any skillful trader would also have a stop loss order in place in case the price moves against him. That's the price you pay for being in the market to begin with. Stocks are risky which is why the profit potential is so great. If you don't stay on top of things you lose.

You don't think I should be able to cancel that buy order due to the new information?

Consider the following from the actual US Department of Justice press release (linked in the Slashdot story):

Sarao was charged in a federal criminal complaint in the Northern District of Illinois on Feb. 11, 2015, with one count of wire fraud, 10 counts of commodities fraud, 10 counts of commodities manipulation, and one count of âoespoofing,â a practice of bidding or offering with the intent to cancel the bid or offer before execution.

There is a specific meaning to "spoofing" which involves somehow canceling bids before execution (and somehow doesn't apply to current HFT). Rather than make that impossible to do in the various markets (or the other alternative, simply not caring), they make it illegal for anyone that falls afoul of the US government.

So lets say I have a standing order to buy FooBar stock at $50 a share. Its current price is $55. So basically I'm looking to buy on dips.
Tonight it comes out that the CEO has been falsifying all financial reports, and instead of making money for the last 3 years they've lost millions. You don't think I should be able to cancel that buy order due to the new information?

You're missing the part where he cancelled after having his offer accepted, and did so repeatedly, with no intention to sell, until he d

The 'willing to fill' part might be key - as he had no intentions of filling the orders that led to the mini-panic, using them solely to affect the price for personal gain.

Defendant willfully and knowingly, having devised andintending to devise a scheme and artifice to defraud, and forobtaining money and property by means of false andfraudulent pretenses, representations, and promises, didtransmit and cause to be transmitted by means of wirecommunication in interstate and foreign commerce,writings, signs, signals, pictures, and sounds for thepurpose of executing such scheme and artifice.

I can't see why the stock market has to be in real time. Is there any advantage to genuine investors in having millisecond transaction times? Why not take orders in real time, but only execute them each hour on the hour? Seems like this would still allow for genuine trades while keeping the ratbags at bay.

Yeah, but I work in this field, and I can tell you that MOST bids and offers aren't acted on, and MOST of them are far 'off the money'. HOWEVER, every single bid or offer placed upon the market, and the CME surely counts, is financed. You simply cannot put a bogus order onto the CME, the NYSE, or even the most rinky-dink ECN. So, the question remains "so what?", the man's money was where his mouth was, and its up to other people to decide what to buy or not buy.

The real point is, there's no clean line here. Normal market activity consists of trying to get other people to buy high and sell low so you can do the opposite. Its a zero-sum game and you cannot point to one bid or offer and say "that's fraudulent" and another essentially identical one and say it isn't. I mean I've literally traded the E-Mini on the CME, just like this guy did. Our algos put in multiple orders at multiple price levels and pegged them a few pips off the BBO. How is it that my order flow is legal, but his almost indistinguishable one isn't? I think there's about a snowball's chance in hell they can show he did anything criminal. I mean its possible, there could have been other activities that crossed certain lines, having insider information of some sort, etc, but just placing orders on a market? I defy any prosecutor to make a case that such a thing is criminal.

Yeah, neither am I. I have a partner who's a Series 7 FINOP/ROP, and licensed with the NFA, CFTA, and FINRA. I'm sure if I ask him he'll give a rather definitive answer. I know from experience what it is likely to be though, which is basically that the big players are all scum and the only reason this guy is in trouble is because he stole candy from the town bully, not because he did anything they don't do on a daily basis. As I've said in other posts though, there COULD be specific illegal acts, using insi

As long as you place trades on the book that you're willing to fill based on the rules of that market there's no reason why you should be called a 'crook' for that.

He didn't do that.

By allegedly placing multiple, simultaneous, large-volume sell orders at different price points—a technique known as “layering”—Sarao created the appearance of substantial supply in the market. As part of the scheme, Sarao allegedly modified these orders frequently so that they remained close to the market price, and typically canceled the orders without executing them.

He places many sell orders with no intention of filling them. While it is fine to cancel an order it becomes manipulation when one places and cancels many orders.

It sounds like it's a flaw in the NYSE and similar exchanges as well as greedy HFT algorithms. It seems like fixing these flaws is far more important than just arresting people who exploit them.

Who was actually harmed by this crash? A bunch of wall street speculators running computer programs to trade faster than regular people. Who gives a shit. If anything, it exposes the vulnerability so it can be fixed.

It's entirely possible to have an exchange where there is no unfair advantage given to people who have paid for faster access to trade offers. But this is the system Wallstreet wants, and I can't say I feel bad when crooks get cheated.

Anyone who owned those stocks, of who owned funds which own those stocks, or who own index stocks, or... really potentially a whole lot of ordinary people, not just "a bunch of wall street [sic] speculators".

There's your answer. He did exactly what they do, but did it cleverly enough to remove the speed advantage. As a result, the money flowed the 'wrong' way and so Wall Street's pet investigators must put a stop to it.

While I agree with your premiss this is exactly what high frequency traders do constantly. This is how they "test the waters" so to speak. The only difference here seems to be the volume of the trades. Money Ball has a reasonable overview of the HFT practice.

How do you know a guy who wrote 30 checks on an account with $0 in it didn't intend to deposit enough to cover the difference?

You don't really. But in the US Legal system enough circumstantial evidence will overcome reasonable doubt every time. And if this guy made loads of money off a crash caused by these tactics, and then continued to use the same damn tactics for years and years, it's really hard to believe it was an accident.

The CME, and EVERY SINGLE OTHER trading venue in existence, requires guaranteed credit before you trade. You simply CANNOT place an order for E-Mini on CME and not be able to make good on it if your bid/offer is accepted. Thus there is no such thing as 'kiting'. Broken trades are VERY rare and if you do break one, there's an investigation and serious penalties are in order. Generally speaking there's someone with the available credit to make the counterparty whole.

So, this Sarao guy for instance, would have been going through someone, say RCG, who is an FCM (Futures Commission Merchant) where he would have say $1 million on deposit. RCG would offer him say 100:1 margin, so he'd make positions as large as $100 million, and if at any point his unrealized P&L grew to close to his $1 million they would call his position and he'd be busted out. At the end of the day he pays RCG some interest on whatever margin he actually used and keeps his profits on whatever he made trading his $100 million in buying power. At NO POINT will RCG ever allow him to be in excess of his credit limit or underwater, and they are regulated and thus guaranteed to have sufficient risk capital to cover any shortfall with the counterparty to any trade on CME. ALL Sarao's trades will be 'given up' to them, or else placed directly through their platform (Onyx 2 I believe currently) and placed by RCG on its omnibus accounts.

The point is, you can't place trades you can't back up, its simply impossible.

HST works the same way. They routinely (and algorithmicly) place a bunch of orders they have no intention of actually executing. That's how they manage to jump in between legitimate trades so they can skim a penny or two off the top.

It'll never happen, but given that it may be hard to convince a jury that the DoJ's claim is true due to the technical nature of the 'crime', I don't see how it's going to improve when commodities and stock traders can manipulate the markets simply through the act of offering to buy and sell.

I don't think you can get rid of computers from trading, but you can remove the advantage that they have. The NYSE is designed as a skewed playing field, giving an advantage to those paying for faster access. I don't think it will be possible to create rules for an exchange that are 100% fair, but I think simply not actively tilting the rules in favor of companies like Goldman Sachs will be an enormous improvement.

There are ways to limit the effectiveness of strategies currently employed by HFT algorithms

So was it illegal to do this? They use the word "scheme" hoping people will mentally prefix it with "Ponzi" in their minds to make it sound illegal, but was it?
Sounds like he was being clever and making money - ain't that the whole point of trading?

Why not just disallow this practice (i.e. by forcing transactions on offers that are accepted) rather than making it illegal? Could it be because big companies also exploit these features (although maybe not so blatantly), to profit?

The thing is that he priced the offers just above market price so they would not be accepted. The volume of his offers made it look like there was lots of supply which made the price go down. He kept following the prices down and rarely sold anything.

My point is - would anyone have cared if he didn't trigger a 1000 pt market slide? This guy is a schemer, no doubt, but doing things that are illegal with a computer keeping tabs on the actions seems dumb, dumber than this guy seems to be.

I think this guy is just getting hanged because safeguards were not in place to prevent these legal actions. If someone is going to be hanged, it has to be the little guy, not the ones that created the system in the first place.

Yes. He's charged "with one count of wire fraud, 10 counts of commodities fraud, 10 counts of commodities manipulation, and one count of “spoofing,” a practice of bidding or offering with the intent to cancel the bid or offer before execution."

My point is - would anyone have cared if he didn't trigger a 1000 pt market slide?

Quit exaggerating; it was only a 600 point slide. That's only $180,000,000,000, or 5.5% of the 30 most important companies in the U.S..

Actually, I'm surprised the guy is still alive; they must be hoping to recover some of the money before they off him.

My point is - would anyone have cared if he didn't trigger a 1000 pt market slide? This guy is a schemer, no doubt, but doing things that are illegal with a computer keeping tabs on the actions seems dumb, dumber than this guy seems to be.

I think this guy is just getting hanged because safeguards were not in place to prevent these legal actions. If someone is going to be hanged, it has to be the little guy, not the ones that created the system in the first place.

No, he was conducting trades apparently to give the impression of an active market without ever intending to actually make the trades. As a result, when other traders made trades he was able to take advantage of the moves and make money. In essence, he cooked the books and then ran off with the cash. the SEC frowns on that.

You can buy a penny stock. You have a First Amendment right to talk it up on penny stock forums. You can then sell for a profit. No single step is illegal. But if the police prove you intended to pump and dump it you have committed a crime. The whole process, taken together, is a crime if they prove you were trying to convince a bunch of idiots to do something stupid (ie: buy your $.05 penny stock for $0.25) that a) cost them money while b) earning you money. You manipulated the market for your personal gain, and that's bad.

This guy made a series of perfectly legal moves that had the effect of a) costing a bunch of idiots to lose money in the Flash Crash while b) he gained money.

A HFT trader uses his knowledge of market conditions (ie: Royal Bank of Canada just placed a major buy order for GM that will jack up the price) to profit. He doesn't try to change the price of anything, he just uses his superior knowledge of what the price is going to do to make a buck.

So how is that not considered insider trading? Or is the GM buy order public knowledge but most people don't have the ability to take advantage of it during the millisecond window?

Seems a big mistake to hinge this on intent. It needs to be clear what actions are punishable, not what state of mind.

Almost all financial crime is intent. You have the right to write a check on an account that has no money in it if you intend to put money in it by the time the check gets to the bank in a few days. If you fail to do so because something stopped you (ie: you get hit by a bus on the way to the bank and go into a coma) you have committed no crime. OTOH if you failed to do so because the original check was a lie you've committed a bunch of crimes.

Ideally you try to make specific actions illegal. However, crooks are clever, and there are far more possible combinations of circumstance than the law can spell out.

Consider this. Should it be legal to swing a bat? Right now, it is legal to swing a bat with the intention of hitting a ball; it is illegal to swing a bat with the intention of hitting a person. I don't think there is any way around that.

Whether it is ethical or not, I suspect that the people involved will shortly be making a 'voluntary payment,' probably 'without admitting wrongdoing' after the regulators have asked pointed questions comparing the actions of their bot against those of the relevant standards.

The markets aren't there for this sort of thing, they're primarily there to fund businesses.

How exactly does high frequency trading fund businesses?

HFT is justified by it's advocates as promoting "liquidity" in markets. Since prices are even more responsive to data the market price is more accurate, and something on the order of 74.2643% of capitalist economic theory is based on the premise that the market price must be 100% accurate at all times be definition.

I don't think that level of liquidity is a particularly strong argument, but that doesn't change the fact that a) they have a justification that cannot be scientifically disproven by economists,

This is basically what Market Making is: Creating a bunch of pending orders that are never triggered to push the market away and into the direction they want.Only the biggest players on the block can get away with doing this because they have billions in equity.... such as the largest 12 banks on the planet.

Always good to know that the value of all our commodities and currencies are controlled by them on a whim, isn't it?Also good to know that they make money by default and can't really lose the game.

This is hardly what market making is. Market makers have *more* legal responsibility than average traders. A market maker must *always* have a bid and ask price showing and they *must* buy or sell at these prices even if it costs them large sums of money. Market making is like a reverse lottery. Usually you make a few dollars on the spread. But you can lose big. Some people use the term "market maker" loosely as you probably are here. But what you are seeing here is a form of market manipulation.

A market maker must *always* have a bid and ask price showing and they *must* buy or sell at these prices even if it costs them large sums of money.

Of course, but that's the point though.... NO-ONE is going to actually trigger these massive orders because they don't have the equity to fill them.Yes, it's a risk that they get hit, but... who would?

Just throw some big stops on in each direction, make it look like there are market participants....

Sounds like he was doing exactly the same as the big players. Making bogus orders to promote a false value in a 'product', waiting for a large rush of buys, then selling before anyone else had time to respond. Exactly the same as the big players, except he didn't bribe the requisite politicians or have the requisite friends at the SEC.

The real people to throw in jail are the ones who made it possible. The guys who deregulated the markets so much, the ones in oversight of the finance system who didn't see these things approaching and the people who dissolved all the protections of the real economy against the finance market because they were greedy for quick bucks.

Politicians, mostly, but we should also go after the lobbyists and their employers who influenced them.

Of course, that will never happen. Society rarely becomes self-conscious enough to get rid of its parasites.

This is ABSURD! He's being singled out because the federal government has granted blanket immunity to the big financial firms and their employees. I guess he didn't bribe the right politicians and didn't provide enough job offers to federal bureaucrats.

Yes, placing orders that you never intend to execute is technically illegal, but the big financial firms that engage in HFT do this crap every f***ing day! Pick a random trading day in the last year and subpoena the order history of a big trading firm. I guarantee that there will be thousands of orders submitted and canceled in milliseconds. Orders which the firm obviously had zero intention of ever executing. Exactly the sort of activity they are calling "criminal" in this one particular case. The U.S. government is a monstrosity. Arbitrary enforcement of the law is a hideous injustice and it's standard procedure in government.

If I was a senator I'd be grilling the AG nominee about this selective enforcement BS.

Perhaps, just maybe perhaps, something that is inherently broken should be broken. As a means by which to increase the prices of commodities, not to the benefit of producers or to the benefit of end consumers purely to create an artificial point by which disgusting individuals can insert themselves into the transaction and claim that price increase as profit for doing nothing other than speculating and seeking purposefully manipulate the price. It ain't stupid to try to eliminate the current commodities pricing scam.

you've got the right idea in a society whose job is to make the world a better place. In the real world though he messed with the investor class. He cost important people lots of money and face. You don't get the break the system those guys set up. They make the rules because they're the ruling class...

Truth is the majority always makes the rules, a corrupt minority just gets away with what the majority lets them get away with, up until the majority stops them from doing so. The illusion that the minority control anything, is just that an illusion, keeping in mind they do readily and perversely enough preferably resort to extremes of violence to sustain that illusion (it's their nature).

Brokers are supposed to offer stock they don't have. In many cases, they are legally required to do so. They have to offer to sell even if they hold no shares. This makes them "naked short." They have to run out and buy the securities before the price moves or they will lose their tail so to speak.

Brokers are supposed to offer stock they don't have. In many cases, they are legally required to do so. They have to offer to sell even if they hold no shares. This makes them "naked short." They have to run out and buy the securities before the price moves or they will lose their tail so to speak.

Not really. They match buyers and sellers so when a buyer's offer meets a sellers ask then the trade occurs. They make their money on the commission, although they could sell the stock from their portfolio if they wanted. Market Makers do that but they are a specialized type of trader, since they keep the market liquid for a specific stock.

That's stupid. You only need to delay settlement by seconds, force the buyer to hold for 6 minutes, and the HFT system is broken.

Or you could levy a truly minimal transaction tax, even processing fee for orders executed in than 250ms from offer to buy to re-offer... Maybe.

But thinking you should force holding stock for days means you need to suspend trading when any news breaks. Which halts the market.

Just slow HFT by milliseconds.

Oh, and audit brokers. If they persist in offering stock they actually don't have, perhaps that's a problem? This whole episode sounds like NASDAQ, except they seem to have the stock.

The argument by HFT traders is that reduces the liquidity and efficiency of the stock market.

They are right in the effect. However, you never see anyone take it to the next step. Do we NEED to market to be THAT liquid?

I, personally, think that the market is currently too liquid if flash crashes can that easily take place on fake orders. It means that the HFT programs are reacting even before the trades have been completed. I agree that they need to be slowed down.

> hat's stupid. You only need to delay settlement by seconds, force the buyer to hold for 6 minutes, and the HFT system is broken.

Yes, and good riddance to it. It's arbitrage on a tremendous scale, sicking thought and personal investment right out of hte market into the pockets of those with the fastest connections. The "high frequency trading" market became very strange when companies started selling FPGA's to connect directly to the fiber optic feeds leaving the stock exchanges. I understand a number o

That wouldn't fix this. It wasn't a matter of him cancelling orders that someone picked up on, it was him placing orders that gave the appearance of a greater market than actually existed, causing the price to move in a certain direction, then cancelling orders before they got picked up.

The risk of investment on the scale of the stock market isn't borne only by the investors. Manipulation gone wrong can destroy economies. Most of the regulation that exists is a reaction to catastrophic losses felt far outside the stock market. It simply isn't reasonable to claim that the problem is overregulation, or that less regulation promotes educated investment or self-policing.

It resulted in huge swings in the market (because scam artists could get away with all kinds of shit), that resulted in major harm for ordinary people because their boss gets his capital from the capitalists on either the stock market or the bond market, and if he can't do that he has to fire you, which means you buy less food, etc.

The panic of 1873, which bore the title "Great Depression" before the one of the 30s, was caused partly because Austria-Hungary's barely regulated stock m

You know that thing penny-stock-bugs get arrested for? They talk down a penny-stock on their forums and get it for a penny, then they use other accounts to talk it up so they can sell it for a quarter? And it's illegal market manipulation because they were making shit up with the intent of acquiring large amounts of money from rubes?

That's precisely what this guy did, except instead of using his First Amendment right to find rubes he used a computer algorithm.